Unión De Empleados De Muelles De Puerto Rico PRSSA Welfare Plan v. UBS Financial Services Inc.

United States Court of Appeals
For the First Circuit
No. 11-1605
UNIÓN DE EMPLEADOS DE MUELLES DE PUERTO RICO PRSSA WELFARE PLAN,
individually and on behalf of all others similarly situated, and
derivatively on behalf of PUERTO RICO FIXED INCOME FUND II, INC.,
PUERTO RICO FIXED INCOME FUND III, INC., PUERTO RICO FIXED INCOME
FUND IV, INC., and TAX-FREE PUERTO RICO FUND II, INC., UNIÓN DE
EMPLEADOS DE MUELLES DE PUERTO RICO AP WELFARE PLAN, individually
and on behalf of all others similarly situated, and derivatively
on behalf of PUERTO RICO FIXED INCOME FUND II, INC., PUERTO RICO
FIXED INCOME FUND III, INC., PUERTO RICO FIXED INCOME FUND IV,
INC., and TAX-FREE PUERTO RICO FUND II, INC.,
Plaintiffs, Appellants,
v.
UBS FINANCIAL SERVICES INC. OF PUERTO RICO; UBS TRUST COMPANY OF
PUERTO RICO; MIGUEL A. FERRER; CARLOS V. UBIÑAS; STEPHEN C.
ROUSSIN; LESLIE HIGHLEY, JR.; MARIO S. BELAVAL; AGUSTÍN
CABRER-ROIG; GABRIEL DOLAGARAY-BALADO; CARLOS NIDO; LUIS M.
PELLOT-GONZÁLEZ; VICENTE J. LEÓN; CLOTILDE PÉREZ;
DOES 1 THROUGH 100,
Defendants, Appellees,
v.
PUERTO RICO FIXED INCOME FUND II, INC.; PUERTO RICO FIXED INCOME
FUND III, INC.; PUERTO RICO FIXED INCOME FUND IV, INC.; TAX-FREE
PUERTO RICO FUND II, INC.,
Nominal Defendants.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Aida M. Delgado-Colón, U.S. District Judge]
Before
Howard, Lipez, and Thompson,
Circuit Judges.
Jay W. Eisenhofer, with whom Mary S. Thomas, Cynthia A.
Calder, Grant & Eisenhofer P.A., Harold D. Vicente-Gonzalez, Harold
D. Vicente-Colon, Vicente & Cuebas, Douglas R. Hirsch, Charles H.
Dufresne, Jr., Sadis & Goldberg LLP, Mark C. Gardy, James S. Notis,
Kelly A. Noto, and Gardy & Notis, LLP were on brief, for appellant.
Paul J. Lockwood, with whom Nicole A. DiSalvo, Skadden, Arps,
Slate, Meagher & Flom LLP, Salvador J. Antonetti-Stutts, Mauricio
O. Muñiz-Luciano, Ubaldo M. Fernández-Barrera, and O'Neill & Borges
were on brief, for appellees UBS Financial Services Inc. of Puerto
Rico, UBS Trust Company of Puerto Rico, Miguel A. Ferrer, Carlos V.
Ubiñas, Stephen C. Roussin, and Leslie Highley, Jr.
Rafael Escalera Rodríguez, Pedro Santiago, and Reichard &
Escalera on brief for appellees Mario S. Belaval, Agustín Cabrer-
Roig, Gabriel Dolagaray-Balado, Carlos Nido, Luis M. Pellot-
González, Vicente J. León, and Clotilde Pérez.
Jose C. Sánchez-Castro and Pirillo Hill González & Sánchez PSC
on brief for nominal defendants.
January 4, 2013
LIPEZ, Circuit Judge. A shareholder derivative action
permits a shareholder of a corporation to bring suit to enforce
rights the corporation is unable or unwilling to enforce on its own
behalf. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 95
(1991). However, to prevent abuse of this procedural device, a
shareholder seeking to assert a cause of action belonging to the
corporation must state with particularity in the complaint either
that the corporation declined to protect its own interests after
suitable demand was made on the board of directors or that such a
demand would have been futile. See Gonzalez Turul v. Rogatol
Distribs., Inc., 951 F.2d 1, 2 (1st Cir. 1991). This case raises
important questions concerning the circumstances in which, under
the applicable law, a presuit demand is considered futile.
Plaintiff-Appellants Unión de Empleados de Muelles de
Puerto Rico AP Welfare Plan ("AP") and Unión de Empleados de
Muelles de Puerto Rico PRSSA Welfare Plan ("PRSSA") are Puerto Rico
pension plans that own shares in closed-end investment funds ("the
Funds") advised by UBS Trust Company of Puerto Rico ("UBS Trust"),
a subsidiary of the Swiss financial giant UBS AG. In 2008, UBS
Trust, acting as the Funds' investment adviser, purchased
approximately $757 million worth of bonds from a series of
issuances underwritten by UBS Financial Services Incorporated of
Puerto Rico ("UBS Financial"), another UBS AG affiliate, and then
sold these bonds to the Funds. As a consequence, the Funds were so
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heavily invested in these bonds that they suffered significant
losses when the value of these bonds soon depreciated.
Plaintiffs brought a shareholder derivative action in
federal district court against the Funds' directors, UBS Trust, and
UBS Financial, who jointly filed a motion to dismiss plaintiffs'
claims. The district court granted the motion to dismiss on the
ground that no presuit demand had been made on the Funds' boards of
directors, and plaintiffs had failed in their complaint to state
with particularity the reasons such a demand would have been
futile. After careful consideration, we vacate the dismissal of
the derivative claims and remand for further proceedings.
I.
The following facts, which we take as true, are drawn
from the allegations in the complaint. See In re Sonus Networks,
Inc., 499 F.3d 47, 66 (1st Cir. 2007).
Plaintiff AP owns shares of four investment funds: the
Puerto Rico Fixed Income Fund II, Inc. ("Fund II"), the Puerto Rico
Fixed Income Fund III, Inc. ("Fund III"), the Puerto Rico Fixed
Income Fund IV, Inc. ("Fund IV"), and the Tax-Free Puerto Rico Fund
II, Inc. ("Tax-Free Fund"). Plaintiff PRSSA owns shares of Fund
II, Fund III, and Fund IV. Though these four funds are separate
investment companies, the board of directors for each fund has an
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identical composition.1 We refer to these four funds collectively
as the "Funds."
Each of the Funds is a closed-end fund, and is
incorporated under the laws of Puerto Rico.2 Generally, such funds
fall under the purview of the Investment Company Act of 1940 ("the
40 Act"). The funds in this case, however, are unusual in that they
are exempt from the 40 Act under section 6(a)(1), which provides an
exemption for certain funds organized in Puerto Rico, so long as
securities issued by that fund are sold only to residents of Puerto
Rico. See 15 U.S.C. § 80a-6(a)(1). To ensure that shares of these
exempt funds are sold only to residents of Puerto Rico, the
securities they issue contain special restrictions on how and to
whom shares of these funds can be transferred or sold. As a
consequence, the pool of potential buyers for these funds is
smaller than the pool available to a typical large, closed-end
mutual fund.
UBS Trust, through its UBS Asset Managers Division,
serves as the investment adviser and administrator for the Funds.
1
"Unlike other corporations, investment companies are
typically created and managed by pre-existing entities known as
investment advisers." Verkouteren v. Blackrock Fin. Mgmt. Inc., 37
F. Supp. 2d 256, 258 (S.D.N.Y. 1999)
2
A closed-end fund is "[a] mutual fund having a fixed number
of shares that are traded on a major securities exchange or an
over-the-counter market." Black's Law Dictionary 1116 (9th ed.
2009).
-5-
As compensation for these services, UBS Trust is entitled to an
annual administrative fee of .15% and an advisory fee of .75%, of
the average weekly gross assets of the Funds.
UBS Trust is an affiliate of, and shares officers with,
UBS Financial, a broker-dealer registered with the Securities and
Exchange Commission ("SEC"). Since 2007, UBS Financial has served
as a financial adviser to Puerto Rico's troubled Employee
Retirement System ("ERS"), which is a public retirement system
maintained by the government of Puerto Rico for its 278,000
retirees and employees.
During the first half of 2008, UBS Financial underwrote
$2.9 billion of bonds issued by ERS. Because an underwriter buys
bonds from an issuer and resells them to investors, with the
difference between the purchase price paid by the underwriter to
the issuer and the resale price accounting for the underwriter's
profit or loss, see John P. Lucas, Pruning the Antitrust Tree:
Credit Suisse Securities (USA) LLC v. Billing and the Immunization
of the Securities Industry from Antitrust Liability, 59 Mercer L.
Rev. 803, 804 (2008); see also In re Scottish Re Group Sec. Litig.,
524 F. Supp. 2d 370, 400-401 (S.D.N.Y. 2007) (defining
"underwriter" for purposes of the Securities Act of 1933), UBS
Financial's profits from these offerings were contingent upon
finding investors willing to buy the ERS bonds at a premium above
the price UBS Financial had paid ERS.
-6-
The ERS bonds were offered for purchase in three series:
Series A in January 2008; Series B in May 2008; and Series C in
June 2008. When there was little global interest in the Series A
offering of the ERS bonds, ERS and UBS Financial abandoned their
initial plans to offer Series B outside of the Puerto Rico market.
Nevertheless, UBS Trust purchased nearly $1.5 billion worth of the
ERS bonds from UBS Financial and then resold them to the funds it
advises, with approximately $757 million worth of the bonds sold to
the Funds at issue in this case. Not only did UBS Trust purchase
more than half of the entire multi-billion dollar offerings, UBS
Trust purchased nearly $850 million, or 85%, of the Series B bonds.
As a result of these purchases, the ERS bonds accounted for more
than thirty percent of the assets of Funds II, III, and IV and
approximately fifteen percent of Tax-Free Fund II.3 For its role
in bringing the bonds to market, UBS Financial shared in
underwriters' fees of $27 million.4
Within one year of issuance, the ERS bonds lost ten
percent of their value, dragging down the worth of the Funds. In
response, and without first demanding corrective action from the
3
To summarize the travel of the bonds: ERS sold the bonds to
its underwriter, UBS Financial, which in turn sold them to UBS
Trust and other buyers. UBS Trust then sold the bonds it had
purchased to the funds it advises, including the Funds at issue in
this case. Plaintiffs in this case are institutional investors in
the Funds.
4
The complaint does not indicate who the other underwriters
were or what percentage of the total fees UBS Financial received.
-7-
Funds' boards of directors, plaintiffs filed a shareholder
derivative suit in February 2010 in federal district court against
the Funds' directors, UBS Trust, and UBS Financial. The complaint
alleged that the institutional defendants engaged in a scheme of
manipulative trading whereby they used the Funds to manufacture the
appearance of market interest in the bonds and drive up the price
other investors were willing to pay for them. Plaintiffs asserted
derivative claims under Rule 10-b5 and Section 10(b) of the
Exchange Act against UBS Trust and UBS Financial, derivative claims
under Section 20(a) of the Exchange Act against certain directors
individually, and derivative claims under Section 12(a)(2) of the
Securities Act against UBS Trust and UBS Financial.5 The complaint
also stated that a presuit demand would have been futile.
Appellees moved to dismiss the derivative claims on the
ground that plaintiffs had inadequately pleaded demand futility.
In opposing the motion to dismiss, plaintiffs requested an
opportunity to cure any deficiencies in the complaint by filing an
amended complaint if the district court were inclined to dismiss
any or all of their claims.
5
In addition to their derivative claims, plaintiffs asserted
direct claims against UBS Trust and UBS Financial on behalf of a
putative class of shareholders for breach of ERISA fiduciary duties
and violations of the duty of good faith. These direct claims were
dismissed by the district court pursuant to Federal Rule of Civil
Procedure 12(b)(6). Their dismissal is not challenged on appeal.
-8-
The district court did not afford plaintiffs any such
opportunity. Instead, it dismissed plaintiffs' derivative claims
without prejudice for failure to properly plead demand futility.
When plaintiffs sought leave to file an amended complaint, the
district court denied plaintiffs' motion, citing our holding in
Fisher v. Kadant, Inc. that "once judgment has entered, the case is
a dead letter, and the district court is without power to allow an
amendment to the complaint because there is no complaint left to
amend." 589 F.3d 505, 509 (1st Cir. 2009). This appeal followed,
challenging both the dismissal of plaintiffs' derivative claims and
the denial of their motion to amend.
II.
We must address a threshold question in this case about
the standard of review that applies to a district court's dismissal
of a shareholder derivative action based on a failure to properly
plead demand futility. Our decisions have left this question open.
See, e.g., Gonzalez Turul, 951 F.2d at 1, 3 (holding that district
court should have dismissed derivative suit but not discussing
standard of review); In re Kauffman Mut. Fund Actions, 479 F.2d
257, 263, 267 (1st Cir. 1973) (affirming dismissal of derivative
suit without describing standard of review). The closest we have
come to setting forth the applicable standard of review was in Heit
v. Baird, where we noted that the district court had not "abused
its discretion" in dismissing a shareholder derivative action. 567
-9-
F.2d 1157, 1161 (1st Cir. 1977). However, we also determined for
ourselves in Heit that the pleadings were inadequate without any
discernible deference to the district court's conclusions, and our
holding said only that dismissal of the case was "proper," id. at
1162, appearing to abjure a more deferential standard of review.
Our view that Heit did not establish the governing standard in this
circuit is confirmed by the conspicuous absence in our subsequent
decisions of any statement to that effect. See Gonzalez Turul, 951
F.2d at 2 (citing Heit but no mention of standard of review);
Marquis Theatre Corp. v. Condado Mini Cinema, 846 F.2d 86, 90-91
(1st Cir. 1988) (same); Grossman v. Johnson, 674 F.2d 115, 123 (1st
Cir. 1982) (same); Untermeyer v. Fid. Daily Income Trust, 580 F.2d
22, 23 (1st Cir. 1978) (same).
Other courts of appeals have traditionally reviewed the
dismissal of a derivative suit based on a failure to properly plead
demand futility for abuse of discretion. See, e.g., Potter v.
Hughes, 546 F.3d 1051, 1056 (9th Cir. 2008); Kanter v. Barella, 489
F.3d 170, 175 (3d Cir. 2007). Recently, however, there have been
expressions of skepticism regarding the appropriateness of this
standard from the Second Circuit, see Kautz v. Sugarman, 456 F.
App'x 16, 18 (2d Cir. 2011); Scalisi v. Fund Asset Mgmt., L.P., 380
F.3d 133, 137 n.6 (2d Cir. 2004), the Ninth Circuit, see Israni v.
Bittman, 473 F. App'x 548, 550 n.1(9th Cir. 2012); Laborers Int'l
Union of N. Am. v. Bailey, 310 F. App'x 128, 130 n.1 (9th Cir.
-10-
2009), and the D.C. Circuit, see Pirelli Armstrong Tire Corp.
Retiree Med. Benefits Trust v. Raines, 534 F.3d 779, 783 n.2 (D.C.
Cir. 2008). As the Second Circuit has observed, the abuse of
discretion standard is incongruous in this context: "[W]hen a trial
court rules on the legal sufficiency of a complaint the question
presented should be one of law. When an appellate court reviews
such a ruling, review should be de novo." Scalisi, 380 F.3d at 137
n.6.
State courts have trended even more strongly toward
plenary review. In 2000, the Delaware Supreme Court expressly
adopted a de novo standard of review, explaining that the nature of
its analysis of a complaint in a derivative suit is no different
than that of a lower court. See Brehm v. Eisner, 746 A.2d 244,
253-54 (Del. 2000). The highest courts of other states have
followed suit. See Fink v. Codey (In re PSE & G S'holder Litig.),
801 A.2d 295, 313 (N.J. 2002); Harhen v. Brown, 730 N.E.2d 859, 866
(Mass. 2000) (same).
We are persuaded by the reasoning in these cases. As a
general matter, rulings concerning the legal sufficiency of
pleadings are reviewed de novo. See Giragosian v. Ryan, 547 F.3d
59, 63 (1st Cir. 2008). There is no justification for treating the
pleadings in a derivative suit differently. A district court is no
better positioned than we are to read and evaluate a complaint in
this sort of action. See Brehm, 746 A.2d at 253-54. Accordingly,
-11-
we now hold that a district court's dismissal of a shareholder
derivative suit based on a failure to properly plead demand
futility is subject to de novo review.
III.
Federal Rule of Civil Procedure 23.1 sets forth the rule
of pleading requiring a shareholder filing a derivative action to
allege with particularity either that a satisfactory presuit demand
was presented to, and refused by, the board of directors or the
reasons such a demand would have been futile. However, the
circumstances in which a demand is required or, conversely, excused
are determined by reference to the law of the state in which the
corporation is incorporated. See Gonzalez Turul, 951 F.2d at 1 &
n.3; cf. Kamen, 500 U.S. at 96-97 ("Rule 23.1 . . . does not create
a demand requirement of any particular dimension."). That is, the
federal rule merely requires that the complaint allege sufficient
facts to enable a federal court to decide whether, as a matter of
state substantive law, a presuit demand was necessary. See
Halebian v. Berv, 590 F.3d 195, 211 (2d Cir. 2009).
Because the Funds are Puerto Rico corporations, Puerto
Rico law ordinarily would inform our analysis as to whether a
demand was excused in this case. However, Puerto Rico law "does
not specifically elaborate the requirements of demand or when it is
excused." Gonzalez Turul, 951 F.2d at 3 n.4. Hence, we look to
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Delaware corporate law, on which Puerto Rico corporate law is
modeled. See id.; Marquis Theatre, 846 F.2d at 91.
Through its opinions in Aronson v. Lewis, 473 A.2d 805(Del. 1984), overruled on other grounds by Brehm, 746 A.2d at 253-
54, and Rales v. Blasband, 634 A.2d 927 (Del. 1993), the Delaware
Supreme Court has established two interrelated tests for demand
futility. "In simple terms, these tests permit a corporation to
terminate a derivative suit if its board is comprised of directors
who can impartially consider a demand." In re Oracle Corp. Deriv.
Litig., 824 A.2d 917, 939 (Del. Ch. 2003). Which test is
appropriate in a given case depends on the nature of the
plaintiff's allegations against the board: Rales applies where the
plaintiff challenges a board's failure to discharge its oversight
duties, while Aronson applies where the plaintiff alleges that the
board as a whole has made a conscious business decision in
violation of its fiduciary duties. See Rales, 634 A.2d at 933("The essential predicate for the Aronson test is the fact that a
decision of the board of directors is being challenged in the
derivative suit."); see also Wood v. Baum, 953 A.2d 136, 140 (Del.
2008) ("The Aronson test applies to claims involving a contested
transaction."); In re Baxter Int'l, Inc. S'holders Litig., 654 A.2d
1268, 1269 (Del. Ch. 1995)(holding that Rales applies where
plaintiffs "do not challenge directors' exercise of business
judgment").
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In the instant case, plaintiffs do not allege that the
boards of each of the Funds made a formal, direct decision to
purchase the ERS bonds. Rather, as is common practice, the
directors delegated the authority to make investment decisions on
behalf of the Funds to the investment adviser, here UBS Trust.
Acting as investment adviser, UBS Trust then executed the purchases
of ERS bonds from UBS Financial and placed them with the Funds. The
Rales standard is thus the best fit for this case. See Rales, 634
A.3d at 933-34 (noting Aronson is inappropriate "where the subject
of the derivative suit is not a business decision of the board");
In re Mut. Funds Inv. Litig., 384 F. Supp. 2d 873, 878 (D. Md.
2005)(applying Delaware law and concluding that Rales was more
appropriate in the mutual fund context).
For a plaintiff to succeed under Rales, she must allege
particularized facts creating "a reasonable doubt that, as of the
time the complaint is filed, the board of directors could have
properly exercised its independent and disinterested business
judgment in responding to a demand." Rales, 634 A.2d at 934.
Applying this test, we look to the individual directors rather than
the board as a whole, and excuse demand "only if a majority of the
board members are interested or lack independence." In re Sonus
Networks, 499 F.3d at 67 (citing Rales, 634 A.2d at 930). A
director is interested "whenever divided loyalties are present, or
where the director will receive a personal financial benefit from
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a transaction that is not equally shared by the stockholders, or
when a corporate decision will have a 'materially detrimental
impact' on a director but not the corporation or its stockholders."
In re Verisign, Inc. Deriv. Litig., 531 F. Supp. 2d 1173, 1189
(N.D. Cal. 2007) (quoting Rales, 634 A.2d at 936). Similarly, a
director's independence may be compromised if he or she is so
personally or financially beholden to an interested person, or an
interested entity, that "his or her discretion [is] sterilized."
Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845
A.2d 1040, 1050 (Del. 2004) (quoting Aronson, 473 A.2d at 816)
(internal quotation marks omitted); see also Orman v. Cullman, 794
A.2d 5, 25 n.50 (Del. Ch. 2002) (explaining that the independence
inquiry "involves an inquiry into whether the director's decision
resulted from that director being controlled by another"); Aronson,
473 A.2d at 816 ("Independence means that a director's decision is
based on the corporate merits of the subject before the board
rather than extraneous considerations or influences."). Though
disinterest and independence are separate concepts, "similar
factual circumstances may implicate both interest and
independence." Orman, 794 A.2d at 25 n.50.
In evaluating the directors' disinterest and
independence, Delaware courts have understood Rales to signal a
kind of realism in analyzing the human dynamics at play in a
director's relationships. See Mizel v. Connelly, No. 16638, 1999 WL
-15-
550369, at *3 n.1 (Del Ch. Aug. 2, 1999) (describing the Rales
standard as a "pragmatic, realist approach"); Steiner v. Meyerson,
No. 13139, 1995 WL 441999, at *10 (Del. Ch. July 19, 1995)
("Realism of the kind signaled by Rales requires one to acknowledge
the possibility that a partner at a small law firm bringing in
close to $1 million in revenues from a single client in one year
may be sufficiently beholden to, or at least significantly
influenced by, that client as to affect the independence of his
judgment.").
Turning to the instant case, we find that the district
court's analysis of whether plaintiffs had established demand
futility was flawed in two significant ways. First, in analyzing
each director, the district court focused too narrowly on whether
plaintiffs had alleged that the individual directors received a
financial benefit from the ERS bonds transaction. Alleging the
receipt of a personal financial benefit is not the sine qua non of
demand futility. Rather, Rales requires the trial court to analyze
more broadly the facts alleged concerning the circumstances of each
director to determine whether plaintiffs have created a reasonable
doubt that the director could objectively evaluate demand "without
regard for" inappropriate influences. Aronson, 473 A.2d at 815. In
other words, the district court should have considered whether
plaintiffs had pled facts sufficient to demonstrate that each
director has such significant connections to the defendants,
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whether personal, financial, or otherwise, that he could not
"impartially consider [demand] without being influenced by improper
considerations." Rales, 634 A.2d at 934.
Second, the district court misconstrued plaintiffs'
burden of demonstrating that the benefits –- financial or otherwise
-– that the individual directors received from their place in the
constellation of relationships between UBS Financial and UBS Trust
were of "subjective material significance" as required under Orman,
794 A.2d at 25 n.50. To demonstrate subjective materiality,
plaintiffs in a shareholder derivative suit "need not [offer]
conclusive evidence of the materiality," but they must "provide the
Court with some particulars from which it could reasonably be
inferred that [the director's] objective judgment would be
impaired." MCG Capital Corp. v. Maginn, No. 4521-CC, 2010 WL
1782271, at *20 (Del Ch. May 3, 2010) (emphasis supplied). In
reviewing the disinterest and independence of each individual
director in this case, however, the district court repeatedly
declined to make such reasonable inferences of materiality from the
facts alleged by plaintiffs. For example, the district court
concluded that the allegations that one director was CEO of both
institutional defendants did not raise a reasonable doubt about his
ability to independently evaluate demand in this case because these
facts were insufficient to establish that these positions were
"subjectively material." In looking for more conclusive evidence of
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materiality, the court overstated the burden plaintiff bears, and
ignored the type of information available to plaintiffs at the
pleading stage. See Rales, 634 A.2d at 934 (reasoning that
plaintiffs should not be saddled with an "extremely onerous burden
to meet at the pleading stage without the benefit of discovery").
At best, plaintiffs can only plead the particular facts of each
director's public circumstances. It is then up to the court to
evaluate the facts alleged regarding each individual director in
light of common sense and practical experience in drawing an
inference of subjective materiality.
IV.
With these errors in mind, we turn to the individual
directors. As noted, each of the Funds is overseen by an identical
eleven-member board of directors. Thus, for plaintiffs to
establish demand futility, the complaint must create a reasonable
doubt that at least six of the directors were not disinterested and
independent under the Rales standard at the time of filing. Because
Delaware law requires a plaintiff pleading demand futility to
"allege facts as to the interest and lack of independence of the
individual members of that board," we examine the facts plead
concerning each director separately. Orman, 794 A.2d at 22.6
6
In our discussion of the individual directors, we rely on
the facts alleged in the complaint. For the purposes of our demand
futility analysis, we take these facts as true. See In re Verisign,
Inc., 531 F. Supp. 2d at 1187.
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A. The Individual Directors
1. Leslie Highley, Jr.7
We begin with the most straightforward case. Plaintiffs
allege and defendants do not contest that Leslie Highley, Jr. is an
insider with extensive ties to UBS AG affiliates. In addition to
being a director of each Fund, Highley is an executive employee of
both UBS Trust, where he is Managing Director and Executive Vice
President, and UBS Financial, where he is Senior Vice President.
For several years, Highley has also acted on behalf of UBS Trust as
portfolio manager for several of the Funds. In other words, Highley
is involved at a high level with both institutional defendants. The
district court correctly held that these facts alone are sufficient
to create a reasonable doubt that he could be disinterested and
independent in evaluating plaintiffs' demand in this case. See
Orman, 794 A.2d at 25 n.50.
7
Four directors – Highley, Ferrer, Ubiñas, and Roussin – are
defendants in this suit in their individual capacity for alleged
violation of section 20(a) of the Exchange Act. Though this
personal liability claim might seem strong support for the
proposition that they could not evaluate demand with disinterest
and independence, the Delaware Supreme Court noted in Aronson that
"the mere threat of personal liability for approving a questioned
transaction, standing alone, is insufficient to challenge either
the independence or disinterestedness of directors." 473 A.2d at
815. Later decisions have interpreted Aronson to mean that only a
"substantial likelihood of personal liability" is enough to
establish demand futility. See, e.g., Wood, 953 A.2d at 141 n.11.
Because we find there are significant alternative factual
allegations to establish that a majority of the board was not
independent and disinterested, we pass no judgment as to whether
the allegations against the individual directors create a
"substantial likelihood of personal liability."
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2. Miguel Ferrer
Plaintiffs allege that Miguel Ferrer serves as both
Chairman and President of the Board of Directors of each of the
four Funds. At the time of the ERS bond offering, Ferrer was also
the Chief Executive Officer of both UBS Trust and UBS Financial.
Before the complaint was filed, Ferrer concluded his employment
with both UBS Financial and UBS Trust, but he did not leave the UBS
AG family. Instead, at the time the complaint was filed, Ferrer was
the Chairman of yet another UBS-affiliated entity known as UBS
International & Puerto Rico ("UBS International").
Though the district court was correct in its ultimate
conclusion that plaintiffs had created a reasonable doubt about
Ferrer's ability to objectively evaluate demand, it improperly
considered Ferrer's circumstances at the time of the ERS bonds
transaction. By contrast, Rales requires the court to consider the
facts pleaded concerning each director's circumstances at the time
the complaint was filed. See Rales, 634 A.2d at 933-34 ("[A] court
must determine whether or not the particularized factual
allegations of a derivative stockholder complaint create a
reasonable doubt that, as of the time the complaint is filed, the
board of directors could have properly exercised its independent
and disinterested business judgment in responding to a demand."
(emphasis supplied)).
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Considering only the facts alleged concerning Ferrer's
circumstances at the time the complaint was filed, we conclude that
plaintiffs have established a reasonable doubt that Ferrer could
have exercised his "independent and disinterested business judgment
in responding to a demand." Rales, 634 A.2d at 934. Even though
Ferrer was no longer a full-time employee at UBS Trust and UBS
Financial, his extensive past ties to both UBS Trust and UBS
Financial are important factors in our analysis. See Krantz v.
Fidelity Mgmt. & Research Co., 98 F. Supp. 2d 150, 156 (D. Mass.
2000) (citing with approval ten factors set out by the SEC relevant
to determination of control over directors which included "former
business associations between the director and the controlling
person"); In re Trump Hotels S'Holder Deriv. Litig., Nos. 96 Civ.
7820, 8527, 2000 WL 1371317, at *9 (S.D.N.Y. Sept. 21, 2000)
("[Director's] history of personally beneficial affiliation with
Trump-controlled entities . . . diminishes the possibility that
[he] had only the corporation's interests in mind when evaluating
the transaction."). In particular, Ferrer's ability to leave his
former UBS positions and assume a new role at a different UBS
affiliate suggests that Ferrer has been able to leverage the
relationships and goodwill he has built in the UBS family of
companies into advancing his career. Given this history, we agree
with the district court that plaintiffs have established a
reasonable doubt that Ferrer could objectively evaluate the demand.
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3. Carlos Ubiñas
According to the facts alleged in plaintiffs' complaint,
Carlos Ubiñas is Vice Chairman of the Board of Directors and
Executive Vice President of each of the Funds. Like Highley and
Ferrer, Ubiñas serves in multiple executive positions at UBS AG
affiliates. Since 2005, Ubiñas has been the President of UBS
Financial, the institutional defendant that received substantial
remuneration for its services as a financial advisor to ERS and
shared in $27 million in underwriting fees for its role as lead
underwriter for the $2.9 billion bond offering at the heart of this
dispute. He is also currently the CEO of UBS International, the
same UBS AG affiliate where his fellow director Ferrer is Chairman.
As both president of defendant UBS Financial and a
director of each Fund, Ubiñas's loyalties would necessarily be
divided in evaluating plaintiffs' demand between his obligations to
the Funds and his obligations to UBS Financial. See In re Verisign,
Inc., 531 F. Supp. 2d at 1189 ("Directorial 'interest' exists
whenever divided loyalties are present. . . ."). Similarly, as
President of UBS Financial and CEO of another UBS AG affiliate,
Ubiñas is beholden to the UBS defendants. See In re NutriSystem,
Inc. Deriv. Litig., 666 F. Supp. 2d 501, 515 (E.D. Pa. 2009)
("Delaware courts have found that directors . . . lack independence
because of their substantial interest in retaining their
employment."); In re The Student Loan Corp. Deriv. Litig., 2002 WL
-22-
75479, at *3 & n.3 (concluding that directors who "owe their
livelihood" to institutional defendant could not consider demand
without "ponder[ing] the effect affirmative action on a demand
would have on [their] future"); see also Rales, 634 A.2d at 937;
Mizel, 1999 WL 550369, at *3 (finding directors lacked independence
where they could not "consider the demand on its merits without
also pondering whether an affirmative vote would endanger their
continued employment").
The district court concluded that these facts were
insufficient to establish a reasonable doubt that Ubiñas could
evaluate demand objectively. We disagree. Viewing the facts
alleged concerning Ubiñas's circumstances as a whole, we conclude
that plaintiffs have created a reasonable doubt that Ubiñas could
"impartially consider [the] merits" of bringing a lawsuit alleging
that his employer, UBS Financial, engaged in an unlawful scheme
"without being influenced by improper considerations." Rales, 634
A.2d at 934.
4. Stephen Roussin
Like Ubiñas, Stephen Roussin is a Director of each of the
Funds and a full-time employee of UBS Financial, where he is the
Managing Director. For the same reasons discussed in relation to
Ubiñas, we conclude that plaintiffs have plead sufficient facts to
raise a reasonable doubt as to Roussin's independence and
disinterest in evaluating the demand.
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5. Mario Belaval
According to the allegations in plaintiffs' complaint,
Mario Belaval's principal employer is Triple S, the largest managed
care company in Puerto Rico, where Belaval is Vice Chairman.
Belaval is also a director of twenty-three UBS-affiliated funds,
including the four Funds at issue in this case. In the recent
past, Triple S has enjoyed a lucrative relationship with UBS
Financial and UBS Trust. In fact, in 2006, with the help of UBS
Trust and UBS Financial, Triple S engaged in a transaction similar
to the ERS bonds offering at issue in this case. In the 2006
transaction, UBS Financial served as the placement agent for a $35
million bond offering from Triple S. UBS Trust purchased this
entire offering, and then re-sold the notes to several of the funds
it advises, including Fund IV. In other words, Belaval is an
officer of a company that benefitted significantly from the same
affiliation that is at the heart of this case, using UBS Financial
to sell Puerto Rican securities to UBS Trust for resale to its
exempt funds. Plaintiffs allege that Triple S's previous use of
the relationship between UBS Financial and UBS Trust gives Belaval
"reason to discourage scrutiny of any similar related-party
transactions, such as the purchase of the ERS Bonds."
In addition to Belaval's prior reliance on UBS Trust and
UBS Financial to raise capital, plaintiffs allege that by remaining
in the good graces of UBS affiliates, Belaval would receive
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benefits including "opportunities to use UBS captive funds to
support [his] other business ventures." These opportunities are
particularly valuable to businesses in Puerto Rico because UBS
Trust is "the largest asset manager" in Puerto Rico, and UBS Trust
and its "alter ego" UBS Financial "are an unusually pervasive force
in Puerto Rico's financial markets."
In deciding that plaintiffs had not established a
reasonable doubt about Belaval's independence, the district court
failed to consider the facts alleged as a whole about Belaval's
relationships with the institutional defendants. See In re Trump
Hotels, 2000 WL 1371317, at *9 (noting that while one allegation
standing alone "is insufficient to raise a reasonable doubt[,] . .
. the totality of the circumstances raises a reasonable doubt" as
to the director's independence). The district court should have
considered Belaval's previous professional relationships with both
institutional defendants and the possibility that Belaval will need
the assistance of the UBS defendants in the future as a
constellation of facts which, considered together, create a
reasonable doubt about Belaval's independence. See, e.g., id. at *8
("Courts have considered the possibility of future influence or
remuneration as a factor when weighing director independence.");
Krantz, 98 F. Supp. 2d at 156 (listing factors relevant to
determining whether a director is controlled including "former
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business associations between the director and the controlling
person").
Similarly, the district court incorrectly dismissed
plaintiffs' characterization of Belaval's entanglements with the
institutional defendants as "conclusory allegations," and failed to
make reasonable, common sense inferences from the facts alleged in
the complaint. See In re Oracle Corp., 824 A.2d at 943 (reasoning
that in assessing a director's independence the chancellor must
"necessarily draw on a general sense of human nature"). The
complaint depicts the institutional defendants as powerful actors
in Puerto Rico's capital markets who play multiple roles in
Belaval's life: employer, underwriter, investor, and gate-keeper to
Puerto Rico's capital markets. For Belaval, deciding to bring
plaintiffs' lawsuit would mean not only suing two institutions that
are important to Triple S, but also accusing four of his co-
directors – who are themselves prominent players in Puerto Rico's
business community – of violating federal securities law.
Considering all of these allegations together, we conclude that
plaintiffs have established a reasonable doubt that a person in
Belaval's position could evaluate demand in this case without
"ponder[ing] the effect affirmative action on a demand would have
on [his] future." In re The Student Loan Corp., 2002 WL 75479, at
*3.
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6. Vincente Leon
Finally, we examine the facts alleged concerning director
Vincente Leon, which are nearly identical to those regarding
Belaval. Leon is both a director of each of the Funds and a vice-
chairman of Triple S. He sits on the boards of many UBS Trust
affiliated funds. Under these circumstances, Triple S's past use of
the UBS affiliates' financial network in a transaction similar to
the ERS bonds transaction, UBS Trust's significant past purchases
and current holdings of Triple S notes, the power of the UBS
defendants in Puerto Rico's financial markets and the likelihood
that in the future Leon will need assistance from the UBS
defendants in accessing the Puerto Rican markets, lead us to
conclude that plaintiffs have plead sufficient facts to create a
reasonable doubt that Leon could objectively consider the demand.
V.
In summary, the plaintiffs' allegations have established
with sufficient particularity a reasonable doubt about the ability
of the six directors identified above to evaluate plaintiffs'
demand to bring this action on behalf of the Funds with the
disinterest and independence required under Puerto Rico law.
Because the boards of directors of the Funds have eleven members,
plaintiffs have established under Rales that a presuit demand would
have been futile. The district court erred in reaching a contrary
conclusion. Plaintiffs' derivative claims should not have been
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dismissed. We therefore vacate the dismissal of those claims and
remand for further proceedings consistent with this opinion.8
Costs are awarded to the appellants.
So ordered.
8
In light of this decision, there was no need for plaintiffs
to file an amended complaint. However, if plaintiffs wish to file
an amended complaint for reasons unrelated to the sufficiency of
their demand futility pleadings, they will have an opportunity to
request permission to do so upon remand.
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